The College Cost Reduction and Access Act, signed into law in September 2007, included a new auction program to determine taxpayer subsidy levels paid to private lenders that make federal student loans. The auction program applies to all federal parent PLUS loans made in the 2009-2010 academic year and thereafter. The first auction was scheduled for April 15, 2009, and winning bidders were to be announced by the U.S. Department of Education on April 24th. Due financial market disruptions and other factors, however, the auction failed to attract sufficient bids and the Department of Education canceled the program on April 29th, 2009. It is unclear at this time if the Department will proceed with the auction in future years.

Under the new auction program, the federal subsidy paid to lenders making PLUS loans will be set through a competitive bidding process. The number of lenders making PLUS loans will decline, but borrower terms for PLUS loans, such as interest rates and repayment length, will remain the same and continue to be set in federal law.

Federal PLUS Loans

The federal government makes subsidized loans available to the parents of undergraduate college students to help ensure students have access to the funds they need to pay for school. Students may borrow limited amounts under the federal Stafford loan program. But parents of undergraduates can take out federal PLUS loans to cover a student’s full cost of college attendance – which includes tuition, housing, and other expenses. In 2006, Congress expanded PLUS loan eligibility to allow graduate students to borrow loans for themselves. Thus, PLUS loans now offer an additional federal loan source for borrowers who exhaust the annual graduate student Stafford loan limit. The new auction, however, applies only to parent PLUS loans.

PLUS loan borrowers pay a fixed 8.5 percent interest rate (7.9 percent for PLUS loans delivered through the Direct Loan program). Unlike Stafford loans for students, PLUS borrowers must satisfy a credit check. Loans generally must be paid back over 10 years, but repayment can be extended through the consolidation loan program.

Subsidies for PLUS Lenders: The Old System

Under the current and soon to be "old" PLUS loan system, any private lender can issue federal PLUS loans. Parents, graduate students and schools are free to choose any PLUS loan lender participating in the program, which forces lenders to compete for loan business from schools and borrowers. In the 2006-2007 academic year, 1363 private lenders made PLUS loans, according to the U.S. Department of Education.

All private lenders that make PLUS loans receive the same subsidy rate from the federal government for providing the loan. This subsidy rate is predetermined by Congress and written into federal law. Specifically, the lender receives a guarantee from the federal government against 97 percent of any default loss on the loan. Additionally, the federal government eliminates all interest rate risk on the loan. While the borrower pays a fixed 8.5 percent interest rate, the government makes subsidy payments directly to PLUS loan lenders to ensure interest payments each quarter are no less than three-month market interest rates, plus a premium of 1.79 percentage points.

PLUS Loan Auction Details

Beginning with academic year 2009-2010, only private lenders that win the right in a competitive auction will be able to make PLUS loans to parents. Before the start of the school year, the U.S. Department of Education will conduct an auction in each of the 50 states in which lenders may bid for the right to make parent PLUS loans in a particular state.

The auction utilizes the old PLUS loan subsidy structure, but the subsidy amount will be subject to competitive bidding. Specifically, interest rates guaranteed to a PLUS lender will continue to be based on three-month market interest rates. However, a lender bids for the right to make parent PLUS loans in a given state by proposing a premium over the market interest rate that they will accept as a subsidy for making federal PLUS loans to all eligible borrowers in a particular state. For example, a lender might bid an interest rate premium of 1.6 percentage points over short term interest rates. The lender would then receive subsidy payments in the same manner as the old system, but the interest rate would be based on a premium of 1.6 percentage points, not the 1.79 that is written into law under the old system.

In each state, the lenders that submit the two lowest bids on the interest rate premium will be awarded the right to make all federal PLUS loans for two years. All PLUS loans made in that state will carry the lender interest rate subsidy equal to the second lowest bid submitted to the U.S. Department of Education during the auction. Again, the borrower interest rate of 8.5 percent will not change.

For example, if the two lowest premium bids in a given state are 1.5 percentage points and 1.2 percentage points above the three-month market interest rate, all PLUS loans made in that state by the two winning lenders will receive an interest rate subsidy equal to three-month market interest rates, plus a premium of 1.5 percentage points, the rate in the second lowest bid. Lenders may not bid higher than a premium of 1.79 percentage points. All bids are confidential and never disclosed publicly.

New auctions are to be held every two years. However, the right to make federal PLUS loans applies to the cohort of borrowers that enters school in the two years covered by each auction. Thus, auction winners have the right to make PLUS loans to the next two classes of borrowers that enter college for the duration of time the students spend enrolled in an institution of higher education. Parents who borrowed PLUS loans prior to the start of the auction program in July 2009 may continue to borrow with any lender. Lenders must provide a 0.25 percentage point interest rate reduction for borrowers who enroll in an electronic repayment plan. Lenders are, however, prohibited under the auction from offering any other borrower benefits, such as interest rate reductions for on-time repayment.

In addition to the interest rate subsidy provided to lenders making PLUS loans, the loans made under the new auction arrangement will carry a 99 percent guarantee, 2 percentage points higher than the current subsidy rate. Additionally, all fees that the federal government normally collects from lenders making federal student loans are waived for loans covered by the auction. Congress made these two changes – the higher guarantee rate and the fee waiver - for PLUS loans under the auction pilot to simplify the program for participating lenders. A less complicated loan program is expected by the Congressional Budget Office to generate more competitive bids from lenders.